Bank Bondholders Now In The Governments Gun Sights

MarketWatch is reporting that the government is contemplating “incenting” bank preferred shareholders and bondholders to convert their interests to common equity.

The government’s effort to convince bondholders and some preferred shareholders to convert their stakes to common shares is part of a larger federal endeavor to improve the total capital of the 19 banks. Treasury and bank regulators are conducting stress tests on this group of banks, with results expected on May 4. Based on the test findings, bank regulators may take steps to hike the common shareholdings of troubled financial institutions, including the conversion of billions in government preferred shares into common stakes.

However, the Treasury department is hoping to convince many of bondholders and preferred investors to convert their stakes to common shares by offering them guarantees against certain losses as common shareholders.

Is it just me or does all of this begin to paint a picture of a banking industry that is flat broke. Aren’t we essentially talking about a total recapitalization of these banks between the conversion of government interests to equity and this initiative? This has the feel of a restructuring in lieu of bankruptcy.

One further thought. If the U.S. banks are this far under water what does that say about their European brethren. If it is that bad for them, how do their governments tackle the problem given the relative size of the banks to their home countries economies.